Shrink the State catastrophe fund and use private market risk transfer instruments

The headline above is something that we hear every year as the U.S. hurricane season approaches and legislators begin their annual discussions about the best way to manage and run State wide catastrophe insurance funds and insurers of last resort. In recent years the discussions have been getting so complex, and often misguided, that no action is taken and the structure of State schemes remain as they have ever been.

This year the message does seem to have been clarified somewhat and the debate feel’s more focused on the main issues of removing the liability for a major storm from the taxpayer and re-introducing the private reinsurance market into the mix.

Using Florida as an example, the Hurricane Catastrophe Fund in the State has assets of around $6 billion available to help insurers such as Citizens pay off claims after major hurricanes. It’s widely accepted that any major storm which hit one of the larger cities in Florida would likely cause in excess of $20 billion in damages (much higher in an extreme case). This would leave the cat fund needing to issue bonds and collect thousands from every family in the State to pay for them. To collect that much money from the public would require some new kind of tax system which would be expensive and unpopular to enforce. Not an ideal situation and to try to enact this while the State is recovering from a major disaster would be hard.

It’s hard to see how the above can be a sustainable way of protecting a State from hurricane damage costs. It’s unfair to taxpayers, could end up being costly to implement and would take years for the fund to recoup the costs of bonds it issued.

Perhaps the hurricane and windstorm funds should align their risk management and risk transfer strategies with similar organisations such as the California Earthquake Authority. The CEA have used a mix of public money, private reinsurance and also catastrophe bonds as part of a risk transfer strategy, thus reducing the taxpayers liability. Some liability will likely always exist for the taxpayer, a disaster of huge magnitude will always increase the cost of living to some degree, but by utilising the private market and all available risk transfer tools it can be minimised significantly.

Sadly in Florida, politics seems to be getting in the way with legislators and politicians using the argument as a tool to win votes rather than a way to secure the States financial future. The debate will continue but it seems likely that the increased profile of risk transfer tools such as cat bonds should help to focus the debate and could just become a part of some State catastrophe fund’s risk management solutions.